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Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco, and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 94,000 units for $50 per unit. The variable production costs are $20, and fixed costs amount to $1,540,000. Production engineers have advised management that they expect unit labor costs to rise by 15 percent and unit materials costs to rise by 10 percent in the coming year. Of the $20 variable costs, 50 percent are from labor and 25 percent are from materials. Variable overhead costs are expected to increase by 20 percent. Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 4 percent as a result of increased taxes and other miscellaneous fixed charges.
The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 9 percent during the year.
Required:
a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for “Volume in units” to the nearest whole number and round your answer for “Sales” to the nearest whole dollar amount.)
b. Compute the volume of sales and the dollar sales level necessary to provide the 9 percent increase in profits, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for “Volume in units” to the nearest whole number and round your answer for “Sales” to the nearest whole dollar amount.)
c. If the volume of sales were to remain at 94,000 units, what price change would be required to attain the 9 percent increase in profits? Calculate the new price. (Round intermediate calculations of unit cost and final answer to 2 decimal places.)
Expert Answer
| PRESENT SITUATION: | Total | Per unit | |
| Sales in units | 94000 | ||
| Sales revenue ($50 per unit) | $ 4,700,000 | $ 50.00 | |
| Variable costs: | |||
| Direct materials ($5 per unit) | $ 470,000 | $ 5.00 | |
| Direct labor ($10 per unit) | $ 940,000 | $ 10.00 | |
| Variable overhead ($5 per unit) | $ 470,000 | $ 5.00 | |
| Total variable cost | $ 1,880,000 | $ 20.00 | |
| Contribution margin | $ 2,820,000 | $ 30.00 | |
| Fixed costs | $ 1,540,000 | ||
| Net operating income | $ 1,280,000 | ||
| a) Expected variable costs per unit: | |||
| Direct materials = $5*110% = | $ 5.50 | ||
| Direct labor = $10*115% = | $ 11.50 | ||
| Variable overhead = 5*120% = | $ 6.00 | ||
| Expected variable cost per unit | $ 23.00 | ||
| Expected sales price (with maximum 10% increase = 50*110%) | $ 55.00 | ||
| Expected contribution margin per unit = 55-23 = | $ 32.00 | ||
| Increased fixed cost = 1540000*104% = | $ 1,601,600 | ||
| Now, | |||
| Total contribution margin required to earn profit of $1,280,000 = 1280000+1601600 (expected fixed cost) = | $ 2,881,600 | ||
| Expected contribution margin per unit | $ 32.00 | ||
| Volume in units required to maintain the profit of $1,280,000 = Total contribution margin required/Contribution margin per unit = 2881600/32 = | 90050 | Units | Answer |
| Dollar sales required = 90050*$55 = | $ 4,952,750 | Answer | |
| b) | |||
| Total contribution margin required to earn desired profit of $1,280,000*109% = 1395200+1601600 (expected fixed cost) = | $ 2,996,800 | ||
| Expected contribution margin per unit | $ 32.00 | ||
| Volume in units required to maintain the profit of $1,280,000 = Total contribution margin required/Contribution margin per unit = 2996800/32 = | 93650 | Units | Answer |
| Dollar sales required = 93650*$55 = | $ 5,150,750 | Answer | |
| c) | |||
| Total contribution required (as for b) | $ 2,996,800 | ||
| CM required per unit = Total CM/94000 = | $ 31.88 | ||
| Selling price required to get CM per unit of $31.88 = $31.88+$23 (expected variable cost per unit) | $ 54.88 | Answer | |
